Direct Deposit Your Tax Refund Into Retirement Savings

Last year, three out of four tax filers got refunds from the IRS, averaging $2,782, as of 3rd quarter ($2,895 by year-end). Where did all that money go? American taxpayers report using their refunds primarily to pay down debt, build up rainy day bank accounts and make big purchases. But there’s another option: deposit your refund directly into an individual retirement account.

“I have to remind people: ‘Try to get it into retirement savings,’” says Craig Smalley, an enrolled agent in Orlando, Fla. “It’s something you have to really take advantage of, and the tax code is allowing you to do it. So, why not?” In one case, a new client had been taking his refund and applying it to next year’s taxes year after year. This year Smalley says he plans to direct money into an IRA and a health savings account, and he’ll still get a refund to boot. Really, the only time it makes sense to apply your tax refund towards future taxes is if you owe quarterly estimated taxes on April 15 [April 17, this year], Smalley notes.

Shutterstock

To direct your whole refund into a single IRA, use the direct deposit line on Forms 1040, 1040A or 1040EZ. You’ll need the IRA’s routing and account numbers. Double check them with your IRA provider. Fidelity, for example, explains here how to adjust Fidelity account numbers on IRS forms and warns that deposits in 2018 will default to a deposit for the 2018 tax year unless you call in to designate it as a deposit for the 2017 tax year.

You can direct all—or part—of your refund into a traditional IRA, a Roth IRA or a SEP-IRA (but not a SIMPLE IRA). If you want to split your refund---say putting part into your IRA, part into your spouse’s IRA, and part into a checking account--- use Form 8888. Fortunately, tax software makes filling it in easy. If you use Form 8888, that gives you an additional savings option: you can buy up to $5,000 in series I savings bonds electronically, and they go by direct deposit into your TreasuryDirect account.

You can direct your refund to a health savings account, too. “Retirees usually take money out of an IRA or 401(k) to pay for healthcare and have to pay tax,” says Smalley. “If you use an HSA, you never have to pay tax.”

Want your refund to count as a 2017 IRA contribution? Then it must be deposited into your IRA by April 17th, 2018. So, file your tax return electronically and as early as possible---ideally by mid-March.

Tip: If you’re worried you might need some of the refund for an emergency, use a Roth IRA. In a crunch, you can take back your original contribution without paying taxes or penalties. And if you don’t need the cash, it will grow tax free for retirement.

What if you owe the IRS? Then, run the numbers to see if you fund a traditional deductible IRA how you can come out ahead by saving for retirement. “I’ll create a spreadsheet and show them exactly how much money they can put into an IRA to bring their income tax liability down to zero,” Smalley says.